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Messages - Deanfbe

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1
Entrepreneurship, Innovation and Change: An Overview

Each content mentioned above plays a unique and complementary role, reflecting unity in diversity.

Entrepreneurship
Entrepreneurship is viewed as a field of enterprising social practice that seeks to improve the human and social condition by critically transcending existing technical and practical limitations. Entrepreneurship is enterprising action underpinned by that spirit that embraces Challenges of risks which may be economic, social or political in nature.
An entrepreneur is a person who initiates and manages new ventures. “Initiation” and “Management” are parallel actions of entrepreneurs. Initiation focuses on ‘Choice’ at the outset, where management is concerned with continuation and comprises four main functions: coordination, control, intelligence and strategic planning.

E M Kauffman, an entrepreneurial philosopher defines entrepreneurship as follows:
“Entrepreneurship is a process through which people and teams pursue an opportunity, use resources and initiate change to create value. Entrepreneurs are driven by a need to control their own destinies and bring their dreams to the market place.” According to him an aspiring entrepreneur should possess the following traits:
1.   Determination
2.   Thrive on uncertainty
3.   Self confidence
4.   Energy
5.   Self-discipline
6.   Business knowledge
7.   Good people judgement

Innovation
Innovation focuses on the practical use and potentially entrepreneurial application of new ideas as products of human ability and power for creativity in the interest of socio-economic change. Innovation (as a product of science and technology) is today the foundation of political and socio-economic development characterizing the information-based, knowledge-based society. And yet the process of innovation and change are pre-dominantly driven by the entrepreneurial spirit: the emerging spirit that is willing to address the never-ending challenges for the improvement of the conditions of human and social life.
Innovation is generally viewed as implementation of new idea or moving successfully towards new directions. To make innovation possible some amount of creativity is essential and creativity finds its fulfillment in innovation.
According to Schumpeter, innovation is creative destruction. Growth and development of an economy is largely a function of innovation. Society and businesses are becoming more knowledge based, technology is developing quickly, and aspirations of the workforce are changing entire business environment. To survive and succeed an organization must be flexible and willing to change and create innovative ideas.
In common knowledge, there is hardly any difference between innovation and creativity. However, there is a difference between innovation and creativity. Creative work directs habitual ways of thinking. Innovative work utilizes habits, traditions and cultures to arrive at new ways of doing things.

Change
Change represents perhaps the most fundamental concept; without the possibility of change, the very idea of entrepreneurship and innovation would have little meaning. Though change is often resisted, it is always an opportunity. Resistance may be based on rational or emotional factors, but before any implementation, resistance should be overcome by team building and by giving people ownership and involvement in the change process. Any major change must be well planned and handled with care, change is distributing when it is forced on an organization, and it is exhilarating when done by the organization at its own speed.
Adapting to change is the most significant of all challenges business organizations have to face. Internal reasons for change are pro-active, but when change is triggered by external facts it is reactive.  Change begins and ends with people. So as many people as possible must be involved with the change process, particularly those likely to be affected by the change. Managing change involves change in attitudes, organizational culture and structure, top management commitment, resource availabilities and appropriate tools and techniques.
Change is an inherent characteristic of any organization; all organizations whether in the public or private sector must change to remain relevant. Change can originate from external sources through technological advances or social, political, economic process or it can come from inside the organization as a management response to a range of issues such as changing clients’ needs, costs or human resources or a performance issue. It can affect one small area or the entire organization. Never the less, all changes whether from external or internal sources, large or small, involve adopting new mind sets, processes, policies and behavior.
Irrespective of the way the change originates, change management is the process of taking planned and structured approach to help align an organization with change in its most simple and effective form. Change management involves working with an organization’s stakeholder groups to help them understand what the change means for them, helping them make and sustain the transition and working to overcome any challenges involved from management perspective. It involves the organizational and behavioral adjustments that need to be made to accommodate and sustain change. In Change management, the goal is to replace negative habits with new ones. The prime objective of change management is to bring about significant changes to the way certain jobs, assignments and processes are structured currently so that ultimately the organization can increase its effectiveness.


Professor Rafiqul Islam
Department of Business Administration
Faculty of Business & Entrepreneurship, DIU

2
Business & Entrepreneurship / Some Motivational Adages for Achievers
« on: June 24, 2019, 02:47:33 PM »
Some Motivational Adages for Achievers

An adage is a traditional maxim, a proverb of common experience. These quotes come from many sources. We may find these quotes inspirational.


ATTITUDE:

1. "It's your attitude, not your aptitude that determines your altitude."


2. "Look backwards with gratitude, upwards with confidence and forwards with hope."


3. "Smile and the world smiles with you- cry and you cry alone."


4. "Happiness is not something you find- it's something you create."


5. Be ready for an opportunity when you see it. if your ship doesn't come in- swim out to it."


6. "It all depends on how you look at things and not on how they are."


8. "If you make an effort to change your attitude, life can be very different."


BUSINESS:

1. Business has two seasons- slack and busy."


2. "Business, like religion and science, should know neither love nor hate."


3. "Any manager can reduce prices but it takes intelligence to increase profits."


4. "When two people in the same company always agree, one is unnecessary."



CHANGE:

1. "Nothing is permanent except change. Change is a continuing process- not an event."


2. "There's nothing wrong with change- if it's in the right direction."


3. "Why not accept change- go with it and commit yourself to a life of self improvement."


4. "Success brings growth and growth means change."


5. "The graveyard of business is littered with companies that failed to recognise the need to change."


6. "Life shrinks or expands in proportion to your courage to make changes."


7. "we must always change, renew and rejuvenate ourselves- otherwise we rot."


8. "To aim for perfection you will need to change often."



EDUCATION:

1. "knowledge is power- if applied."


2. "Education is not the filling of a bucket but the lighting of a fire."


3. "I hear and I forget. I see and I remember. I do and I understand."


4. "The world is a classroom and life is a memorable teacher- for those who are prepared to learn."


5. "The difficulty in education is to get experience out of ideas."


6. "To teach is to learn twice."



LEADERSHIP:

1. "A leader is a dealer in hope."


2. "Leadership is largely a behavioral skill. It cannot be taught- only learnt."


3. "The key to leadership is to accept responsibility."


4. "To be a leader you have to be at one with the people you lead."


5. "Good followers don't make good leaders."


6. "Leaders need a clear vision. They should know where they are going."


7. Leaders must be prepared to make the hard decisions."


8. "Leaders who allow others to speak for them abdicate their responsibilities."


9. "Leaders should understand the needs of their followers."


10. "Different situations require different styles of leadership."


11. "Good leaders delegate and keep clam in times of stress."


12. "If you can combine intelligence and humanity with enthusiasm you are likely to be a good leader."


13. "To become a leader- be a leader!"


3
Business Administration / Some valuable quotes for Achievers
« on: June 18, 2019, 04:49:27 PM »
1. "Dream what you dare to dream. Go where you want to go. Be what you want to be."

2. "Believe in yourself and others will too."

3. If your goals are realistic you can achieve anything.''

4. "You could do great things if you weren't so busy doing little things."

5. "People who begin many things finish few."

6. "You don't know what you can do until  you try."

7. "There is nothing like a dream to help plan your future."

8. "Only the first steps to achieve something are difficult- the planning, the getting started."

9. "Well begun is half done."

10. "People will remember what you achieve- not what you promised to achieve."

11. "It is not enough to aim;you must hit your target!"

12. "When you have achieved your goal, satisfaction will be your reward."

13. "Earn a reputation for achieving by meeting deadlines and getting things done."

14. "Try to make every day a day of achievement. What did you do yesterday that was worth remembering today?"

15. 'you can if you believe you can."

4
Business & Entrepreneurship / Some valuable quotes for Achievers
« on: June 18, 2019, 04:48:40 PM »
1. "Dream what you dare to dream. Go where you want to go. Be what you want to be."

2. "Believe in yourself and others will too."

3. If your goals are realistic you can achieve anything.''

4. "You could do great things if you weren't so busy doing little things."

5. "People who begin many things finish few."

6. "You don't know what you can do until  you try."

7. "There is nothing like a dream to help plan your future."

8. "Only the first steps to achieve something are difficult- the planning, the getting started."

9. "Well begun is half done."

10. "People will remember what you achieve- not what you promised to achieve."

11. "It is not enough to aim;you must hit your target!"

12. "When you have achieved your goal, satisfaction will be your reward."

13. "Earn a reputation for achieving by meeting deadlines and getting things done."

14. "Try to make every day a day of achievement. What did you do yesterday that was worth remembering today?"

15. 'you can if you believe you can."

5
One of the primary tenets of accepted central banking thoughts has been the importance of keeping central banks politically independent. No other aspect of central banking has evoked more attention and discussion than the advocacy on making the central bank independent of any political authority. The concept of an independent central bank favors separating the power of creating money from the power of spending the money. Hence, the strongest argument for an independent central bank rests on the view that subjecting the central bank to more political pressure would impart an inflationary bias to the monetary policy. As argued by many observers, politicians in a democratic society are short-sighted, because they are driven by the need to win their next election and they are unlikely to focus on long-term objectives, such as promoting a stable price level. Instead, they will seek short-term solutions to problems, even if the short-term solutions have undesirable long-run effects. A politically-insulted central bank is more likely to be concerned with long-term objectives and thus be a defender of a sound currency and a stable price. Putting the central bank under the control of the government is considered dangerous, because the central bank can be used to facilitate financing large budget deficits and thus this help might lead to a more inflationary bias in the economy. An independent central bank is better able to resist this pressure from any government expenditure without raising taxes. An independent central bank, largely free from political pressure, is needed to ensure justice to those who lose from inflation.

Another argument for a central bank's independence is that the conduct of a monetary policy is too important to leave to politicians who may lack the expertise about making tough decisions on issues of great economic importance, such as reforming the banking system, or reducing the budget deficit. The crucial parameters like price level and exchange rate under no circumstances should be transferred to the political control variable. But removal of the monetary policy from the political sphere is itself a political act. There seems to be an even stronger case for an independent central bank in the developing countries, given the greater frequency and arbitrariness of political change coupled with politicization of finance. A recent research demonstrates that political instability causes instability at the central bank too, although the spillover effect varies from country to country. These are the questions which have not been addressed in the debate on the central bank's independence.

According to some experts, an autonomous central bank is necessary in Bangladesh to conduct a sound monetary policy and exercise utmost prudence in such matters such as licensing new banks and the use of directed credit. Experience with government intervention in these matters in Bangladesh underlines the importance of establishing an autonomous central bank in our country. The boards of directors of state-owned banks and financial institutions need to be constituted with people having sound knowledge about the national economy and the financial sector. However, the Bangladesh Bank has not been given any authority to appoint independent directors to private banks under the recently-amended Banking Companies Act 2013. The Bangladesh Bank can remove MDs of state-owned banks but has no such authority, when it comes to the boards of directors. A strict application of the criteria set by the Bangladesh Bank for selection of qualified persons with good reputation and right professional profile for boards of directors in state-run banks is needed so that the directors in the state-run banks can perform up to the desired level of competence to keep the banking system on the right path.

However, the central bank must show an objective and independent attitude to various sectors and interest in the economy and it should earn a reputation for impartiality. The personality, prestige and the competence of the central bank management in any country can go a long way in persuading the banks and the government to formulate and implement an appropriate monetary policy for a country.

THE CASE AGAINST INDEPENDENCE OF CENTRAL BANK: Proponents of the government's control of the central bank argue that it is undemocratic to have a monetary policy (which affects everyone in the economy) formulated by an elite group responsible to none. The people hold the president or parliament responsible for the economic well-being of the country, yet they lack control over the government agency, the central bank that may well be the most important factor in determining the health of the economy. The monetary policy involves difficult decisions from a long-term perspective. The public hold the government responsible for the economic conditions that result from all the policies followed by the government. Hence the government should have control over the monetary policy. It seems to be undemocratic to say that elected officials, in a parliamentary democracy, should not be trusted to judge the monetary policy. Monetary and fiscal policies should be integrated and   adequate integration cannot be achieved merely by a process of informal consultation. Rather it requires that the central bank becomes part of the administration. Giving the government control over the central bank does not necessarily call for weakening its influence, rather strengthening it. If it was a part of the administration, the central bank advice could then be better heeded by the government. However, there is yet no consensus on whether an independent central bank is a good idea, although the public support for independence of a central bank seems to have been growing in different countries of the world.

The arguments for and against independence of a central bank may give the wrong impression that the choice is between two irreconcilable extremes. But this is not so. Even if the central bank was to lose its formal independence and become a part of the government administration, there could still be an attempt to keep it out of partisan politics.

http://today.thefinancialexpress.com.bd/views-opinion/rules-discretion-and-autonomy-of-central-bank?date=22-01-2014&fbclid=IwAR2BlqeYD6p1m5hj3sRWp8h0v2VGapAf0arNBYKVrOmxjHoEt_kzDr3JOXg

6
BBA Discussion Forum / Autonomy of Central Bank: Rationale and Reality
« on: February 07, 2019, 02:47:02 PM »
One of the primary tenets of accepted central banking thoughts has been the importance of keeping central banks politically independent. No other aspect of central banking has evoked more attention and discussion than the advocacy on making the central bank independent of any political authority. The concept of an independent central bank favors separating the power of creating money from the power of spending the money. Hence, the strongest argument for an independent central bank rests on the view that subjecting the central bank to more political pressure would impart an inflationary bias to the monetary policy. As argued by many observers, politicians in a democratic society are short-sighted, because they are driven by the need to win their next election and they are unlikely to focus on long-term objectives, such as promoting a stable price level. Instead, they will seek short-term solutions to problems, even if the short-term solutions have undesirable long-run effects. A politically-insulted central bank is more likely to be concerned with long-term objectives and thus be a defender of a sound currency and a stable price. Putting the central bank under the control of the government is considered dangerous, because the central bank can be used to facilitate financing large budget deficits and thus this help might lead to a more inflationary bias in the economy. An independent central bank is better able to resist this pressure from any government expenditure without raising taxes. An independent central bank, largely free from political pressure, is needed to ensure justice to those who lose from inflation.

Another argument for a central bank's independence is that the conduct of a monetary policy is too important to leave to politicians who may lack the expertise about making tough decisions on issues of great economic importance, such as reforming the banking system, or reducing the budget deficit. The crucial parameters like price level and exchange rate under no circumstances should be transferred to the political control variable. But removal of the monetary policy from the political sphere is itself a political act. There seems to be an even stronger case for an independent central bank in the developing countries, given the greater frequency and arbitrariness of political change coupled with politicization of finance. A recent research demonstrates that political instability causes instability at the central bank too, although the spillover effect varies from country to country. These are the questions which have not been addressed in the debate on the central bank's independence.

According to some experts, an autonomous central bank is necessary in Bangladesh to conduct a sound monetary policy and exercise utmost prudence in such matters such as licensing new banks and the use of directed credit. Experience with government intervention in these matters in Bangladesh underlines the importance of establishing an autonomous central bank in our country. The boards of directors of state-owned banks and financial institutions need to be constituted with people having sound knowledge about the national economy and the financial sector. However, the Bangladesh Bank has not been given any authority to appoint independent directors to private banks under the recently-amended Banking Companies Act 2013. The Bangladesh Bank can remove MDs of state-owned banks but has no such authority, when it comes to the boards of directors. A strict application of the criteria set by the Bangladesh Bank for selection of qualified persons with good reputation and right professional profile for boards of directors in state-run banks is needed so that the directors in the state-run banks can perform up to the desired level of competence to keep the banking system on the right path.

However, the central bank must show an objective and independent attitude to various sectors and interest in the economy and it should earn a reputation for impartiality. The personality, prestige and the competence of the central bank management in any country can go a long way in persuading the banks and the government to formulate and implement an appropriate monetary policy for a country.

THE CASE AGAINST INDEPENDENCE OF CENTRAL BANK: Proponents of the government's control of the central bank argue that it is undemocratic to have a monetary policy (which affects everyone in the economy) formulated by an elite group responsible to none. The people hold the president or parliament responsible for the economic well-being of the country, yet they lack control over the government agency, the central bank that may well be the most important factor in determining the health of the economy. The monetary policy involves difficult decisions from a long-term perspective. The public hold the government responsible for the economic conditions that result from all the policies followed by the government. Hence the government should have control over the monetary policy. It seems to be undemocratic to say that elected officials, in a parliamentary democracy, should not be trusted to judge the monetary policy. Monetary and fiscal policies should be integrated and   adequate integration cannot be achieved merely by a process of informal consultation. Rather it requires that the central bank becomes part of the administration. Giving the government control over the central bank does not necessarily call for weakening its influence, rather strengthening it. If it was a part of the administration, the central bank advice could then be better heeded by the government. However, there is yet no consensus on whether an independent central bank is a good idea, although the public support for independence of a central bank seems to have been growing in different countries of the world.

The arguments for and against independence of a central bank may give the wrong impression that the choice is between two irreconcilable extremes. But this is not so. Even if the central bank was to lose its formal independence and become a part of the government administration, there could still be an attempt to keep it out of partisan politics.

http://today.thefinancialexpress.com.bd/views-opinion/rules-discretion-and-autonomy-of-central-bank?date=22-01-2014&fbclid=IwAR2BlqeYD6p1m5hj3sRWp8h0v2VGapAf0arNBYKVrOmxjHoEt_kzDr3JOXg

7
Finance & Banking / Autonomy of Central Bank: Rationale and Reality
« on: February 07, 2019, 02:46:44 PM »
One of the primary tenets of accepted central banking thoughts has been the importance of keeping central banks politically independent. No other aspect of central banking has evoked more attention and discussion than the advocacy on making the central bank independent of any political authority. The concept of an independent central bank favors separating the power of creating money from the power of spending the money. Hence, the strongest argument for an independent central bank rests on the view that subjecting the central bank to more political pressure would impart an inflationary bias to the monetary policy. As argued by many observers, politicians in a democratic society are short-sighted, because they are driven by the need to win their next election and they are unlikely to focus on long-term objectives, such as promoting a stable price level. Instead, they will seek short-term solutions to problems, even if the short-term solutions have undesirable long-run effects. A politically-insulted central bank is more likely to be concerned with long-term objectives and thus be a defender of a sound currency and a stable price. Putting the central bank under the control of the government is considered dangerous, because the central bank can be used to facilitate financing large budget deficits and thus this help might lead to a more inflationary bias in the economy. An independent central bank is better able to resist this pressure from any government expenditure without raising taxes. An independent central bank, largely free from political pressure, is needed to ensure justice to those who lose from inflation.

Another argument for a central bank's independence is that the conduct of a monetary policy is too important to leave to politicians who may lack the expertise about making tough decisions on issues of great economic importance, such as reforming the banking system, or reducing the budget deficit. The crucial parameters like price level and exchange rate under no circumstances should be transferred to the political control variable. But removal of the monetary policy from the political sphere is itself a political act. There seems to be an even stronger case for an independent central bank in the developing countries, given the greater frequency and arbitrariness of political change coupled with politicization of finance. A recent research demonstrates that political instability causes instability at the central bank too, although the spillover effect varies from country to country. These are the questions which have not been addressed in the debate on the central bank's independence.

According to some experts, an autonomous central bank is necessary in Bangladesh to conduct a sound monetary policy and exercise utmost prudence in such matters such as licensing new banks and the use of directed credit. Experience with government intervention in these matters in Bangladesh underlines the importance of establishing an autonomous central bank in our country. The boards of directors of state-owned banks and financial institutions need to be constituted with people having sound knowledge about the national economy and the financial sector. However, the Bangladesh Bank has not been given any authority to appoint independent directors to private banks under the recently-amended Banking Companies Act 2013. The Bangladesh Bank can remove MDs of state-owned banks but has no such authority, when it comes to the boards of directors. A strict application of the criteria set by the Bangladesh Bank for selection of qualified persons with good reputation and right professional profile for boards of directors in state-run banks is needed so that the directors in the state-run banks can perform up to the desired level of competence to keep the banking system on the right path.

However, the central bank must show an objective and independent attitude to various sectors and interest in the economy and it should earn a reputation for impartiality. The personality, prestige and the competence of the central bank management in any country can go a long way in persuading the banks and the government to formulate and implement an appropriate monetary policy for a country.

THE CASE AGAINST INDEPENDENCE OF CENTRAL BANK: Proponents of the government's control of the central bank argue that it is undemocratic to have a monetary policy (which affects everyone in the economy) formulated by an elite group responsible to none. The people hold the president or parliament responsible for the economic well-being of the country, yet they lack control over the government agency, the central bank that may well be the most important factor in determining the health of the economy. The monetary policy involves difficult decisions from a long-term perspective. The public hold the government responsible for the economic conditions that result from all the policies followed by the government. Hence the government should have control over the monetary policy. It seems to be undemocratic to say that elected officials, in a parliamentary democracy, should not be trusted to judge the monetary policy. Monetary and fiscal policies should be integrated and   adequate integration cannot be achieved merely by a process of informal consultation. Rather it requires that the central bank becomes part of the administration. Giving the government control over the central bank does not necessarily call for weakening its influence, rather strengthening it. If it was a part of the administration, the central bank advice could then be better heeded by the government. However, there is yet no consensus on whether an independent central bank is a good idea, although the public support for independence of a central bank seems to have been growing in different countries of the world.

The arguments for and against independence of a central bank may give the wrong impression that the choice is between two irreconcilable extremes. But this is not so. Even if the central bank was to lose its formal independence and become a part of the government administration, there could still be an attempt to keep it out of partisan politics.

http://today.thefinancialexpress.com.bd/views-opinion/rules-discretion-and-autonomy-of-central-bank?date=22-01-2014&fbclid=IwAR2BlqeYD6p1m5hj3sRWp8h0v2VGapAf0arNBYKVrOmxjHoEt_kzDr3JOXg

8
The following information may be useful to students of Banking and Financial Markets and Institutions. They are also required to read other Text Books and References.

BANKS`s Loan Policies

Factors that Influence a Bank’s Loan Policies

The restrictions imposed by statutory law and administrative regulations do not provide answer to many questions regarding safe, sound and profitable bank lending, questions regarding the size of the loan portfolio, desirable loan maturities, and the types of loans to be made are unanswered. These questions and many others about lending must be answered by each individual bank. Many banks have developed formal, written lending policies in recent years. Although written lending policies serve a number of purposes, the most important is that they provide guidance for lending officers and thereby establish a greater degree of uniformity in lending practices. Since lending is important both to the bank and to the community it serves, loan policies must be worked out carefully after considering many factors. For the most part, these same factors determine the size and composition of the secondary reserve and the investment account of a bank. Some of the very important factors are mentioned here and discussed only briefly:


1. Capital position
2. Risk and profitability of various types of loans
3. Stability of deposits
4. Economic Conditions
5. Influence of monetary and fiscal policy
6. Ability and experience of bank personnel
7. Credit needs of the area served

Capital Position

The Capital of a bank serves as a cushion for the protection of the depositor`s funds. The size of the capital in relation to deposits influences the amount of risk that a bank can afford to take. Banks with a relatively large capital structure can make loans of longer maturities and greater credit risk.

Risks and Profitability of Different Types of Loan
Since earnings are necessary for the successful operation of a bank, all banks consider this important factor in formulating loan policy. Some banks may emphasize earnings more than others. Banks with greater need for earnings might adopt more aggressive lending policies than those that do not consider earnings to be paramount. An aggressive policy might call for making a relatively large amount of term or consumer loans, which normally are made at higher rates of interest than short-term business loans.

The Stability of Deposits

The fluctuation and types of deposits must be considered by a bank in formulating its loan policy. After adequate provisions have been made for the primary and secondary reserves, banks can then engage in lending. Even though these two reserves are designed to take care of predictable deposit fluctuations and loan demands, unpredictable demands force banks to give consideration to the stability of deposits in formulating loan policy.

Economic Conditions
The economic conditions of the area served by a bank are important in demining its loan policy. A stable economy is more conducive to a liberal loan policy than is one that is subject to seasonal and cyclical movements. Deposits of feast or famine economies (weak economies) fluctuate more violently than do deposits in an economy noted for its stability. Consideration must also be given to the national economy. Factors that adversely affect the nation as a whole, if they are of serious magnitude, eventually affect local conditions.

Monetary and Fiscal Policies
The lending ability of banks is also influenced by monetary and fiscal policies. If monetary and fiscal policies are expansionary and additional reserves are made available to the commercial banking system, the lending ability of banks is increased. Under these conditions banks can have more liberal loan policy than if the opposite situation exists.

The Expertise of Banks Personnel
The expertise of lending personnel is not insignificant in the establishment of bank loan policy. For example, officers may have considerable ability and experience in business lending but practically none in making real estate loans, while in other banks their specialty may be consumer lending. One of the probable reasons that banks ere slow in entering consumer lending field is the lack of skilled personnel. Some banks may be so specialized in certain fields of lending that their presence may influence the loan policy of other banks.

The Area Served by Banks
An obvious factor influencing a commercial bank`s loan policy is the area it serves. The major reason banks are chartered is to serve the credit needs of their communities. If this cannot be done, there is little justification for their existence. Banks are morally bound to extend credit to borrowers who present logical and economically sound loan requests. Banks in areas where the economy is predominantly one of cattle raising, for example, cannot turn their back on this type of lending , but should tailor policy to fit the needs of this economic activity.

The Tools Commercial Lenders Need and Use
A good exercise to demonstrate one of the most important tasks that commercial lenders have to do and one that pulls together the various tools they need is to practice writing a credit memo. Seven keys in preparing such memoranda are:

1. Be brief
2. Interpret the information
3. Concentrate on facts
4. Put yourself in the role of the user
5. Maintain a “big picture” perspective
6. Understand the risk (of Business and Banking)
7. Focus on understanding how the business functions

Given these points, credit memos need to address four key areas:

Management: (who are you lending to) important areas to analyse here include stability, past performance, depth, reputation, planning (e.g. projected performance of the company), and strengths and weakness.

Company Operations: ( what do they do and how do they do it?) important areas to analyse here include definition of market ( product and geographic) , structure of the industry, the four Ps of marketing( product, price, promotion and place) and how they relate to the market and industry , degree of competition and substitutes and basic operations of the business.

Industry: (what does the company face?) important areas to analyse here include structure (e.g. cyclical, seasonal, ease of entry /exit, regulated, unionized, etc), description of the industry, company`s position within the industry, position on the product life cycle, industry trends, future concerns and external concerns.

Financial performance: (Quantitative ability to repay?) important areas to analyse here include interpretation of the numbers, analysis and reflections of financial statements ( balance sheet, income-expense, cash flow), understanding trends and changes and how change in financial performance affects business risk. Successful commercial lenders need good communication skills (verbal and written) and, as evidenced by the preceding list, knowledge of finance, accounting, economics, management, marketing and some computer skills.

The Formal Credit Analysis Procedure

The formal credit analysis procedure includes a subjective evalution of the borrower`s request and a detailed review of all financial statements. The loan officer may perform the initial quantitative analysis for the bank manger. The process consists of:

1. Collecting information for the credit file; such as credit history and performance
2. Evaluation management, the company and the industry in which it operates, i.e., evaluation of internal and external factors
3. Spreading financial statements i.e. financial statement analysis
4. Projecting the borrower`s cash flow and thus its ability to service the debt
5. Evaluating collateral or the secondary source of repayment
6. Writing a summary analysis and making a recommendation
The credit file contains background information on the borrower, past and present financial statements, pertinent credit reports, and supporting schedules such as an ageing receivables, a breakdown of current inventory and equipment, and a summary of insurance coverage. If the customer is a previous borrower, the file should also contain copies of the past loan agreement , cash flow projections, collateral agreements and security documents, and narrative comments provided by previous loan officers, and lending is determining the customer`s and copies of all correspondence with the customer. One of the most important aspects of lending is determining the customer`s desire to repay the loan. Although this is critically important it is difficult to measure. Information in the credit file will give the credit officer information on the customer`s repayment history.

The credit analyst also uses the credit file data to spread the financial statements , project cash flow and evaluate collateral. An evaluation of management, the company, and industry is also needed to ensure safety and soundness of the loan. The last step is to submit a written report summarizing the loan request, loan purpose, and the borrower’s comparative financial performance with industry standards, and to make a recommendation. The loan officer evaluates the report and discusses and errors omissions, and extensions with the analyst.

Structuring A Credit Proposal

The following are the key issues to be subject matter of discussion in a credit proposal:

1. Purpose: The purpose of financing sets the main parameters for designing the credit structure, because it affects the safety of repayment and earrings from the business. The proposal should be bankable. The following proposals are relevant for the purpose: [The Indian Institute of Bankers, 2003].

*Compliance of bank`s internal policy (for example financing for preferred sector and sun rise industries).
• The commercial and economic logic of the purpose to be financed.
• The ability and experience of management to handle the proposed venture.
• Compliance with bank`s legal requirements.
• Legal complications arising from the purpose of the financing which may impair the creditworthiness of the advance.

2. Amount: Is it adequate for the purpose? The loan should be need-based, not more and not less. A bank which lends inadequately not caring how the balance requirement will be funded may create problem for itself as well as for the customer.
3. Margin contribution: This is the stake of the proponent in the project. In project lending secured by fixed assets, a cash contribution from the company itself acts as evidence of commitment and cushion to the lenders against failure of the secured assets to generate repayment. In unsecured transactions the focus shifts to the financial mix of debt and equity.
4. Portfolio consideration: Bank`s proposed exposure to the relevant corporate group/industry should be considered. It is not advisable to put all eggs in one basket.
5. Credit risk and term: Banks will wish to limit their exposure to individual high risk and long term advances more tightly than to lower risk and short term advances.
6. Yield: Increasingly banks are concerned with maximizing their yield from the use of their balance sheet and the amount lent can be a significant determinant of the overall return forms the deal. The more the spread, the better for the bank.
7. Legal consideration: Whether the company has borrowing power to borrow the amount and the bank to lend it.
8. Repayment: The key issue is how the bank is to be repaid and what is the margin of error if operations deteriorate. The following factors will be looked into in this regard.

• The type of repayment source
• The quality of repayment source
• The currency of income from the repayment source
• Cash flow protection (i.e. the margin of error)
• Financial flexibility ( i.e. the alternative sources of fund to cover shortages)
• Asset protection to cover the bank if cash flow is inadequate
• The need for good documentation

9. Security and quasi-security: Security whether main or collateral is the banker`s protection against non-payment from the primary repayment source. It is the insurance against failure and takes the form of a legally enforceable claim on tangible assets or a third party guarantee. However, unsecured transactions may be acceptable where cash flow protection is generous and reliable and adequate asset cover is available through the recourse available for genera creditors of the company.
10. Control and Monitoring: The ability to take control of lending situation, before deterioration in borrower`s condition becomes terminal, is crucial. It is achieved by insertion in the documentation of provisions which if breached, will enable the bank to switch over form term facility to one immediately repayable on demand.
11. Designing Credit Faculties: Designing the details of credit facilities within the broad parameters of benefits to the borrower and protection and remuneration for the bank which broadly involves:

• Fixing up cash credit and working capital demand loan limits
• Bills purchase and / or discounting facilities
• Term loan/ deferred payment facilities
• Contingent liabilities limits for LCs and Guarantees

12. Pricing: This is a very important aspect of lending especially in a competitive environment for achieving satisfactory remuneration for the bank. Pricing is based on the directives issued by the central bank from time to time and the market rates. It will consider:

• The risk-reward ratio
• The cost of administration and overheads
• Capital adequacy cost and cost of statutory reserves
• The need to optimize yields on investments

9
The following information may be useful to students of Banking and Financial Markets and Institutions. They are also required to read other Text Books and References.

BANKS`s Loan Policies

Factors that Influence a Bank’s Loan Policies

The restrictions imposed by statutory law and administrative regulations do not provide answer to many questions regarding safe, sound and profitable bank lending, questions regarding the size of the loan portfolio, desirable loan maturities, and the types of loans to be made are unanswered. These questions and many others about lending must be answered by each individual bank. Many banks have developed formal, written lending policies in recent years. Although written lending policies serve a number of purposes, the most important is that they provide guidance for lending officers and thereby establish a greater degree of uniformity in lending practices. Since lending is important both to the bank and to the community it serves, loan policies must be worked out carefully after considering many factors. For the most part, these same factors determine the size and composition of the secondary reserve and the investment account of a bank. Some of the very important factors are mentioned here and discussed only briefly:


1. Capital position
2. Risk and profitability of various types of loans
3. Stability of deposits
4. Economic Conditions
5. Influence of monetary and fiscal policy
6. Ability and experience of bank personnel
7. Credit needs of the area served

Capital Position

The Capital of a bank serves as a cushion for the protection of the depositor`s funds. The size of the capital in relation to deposits influences the amount of risk that a bank can afford to take. Banks with a relatively large capital structure can make loans of longer maturities and greater credit risk.

Risks and Profitability of Different Types of Loan
Since earnings are necessary for the successful operation of a bank, all banks consider this important factor in formulating loan policy. Some banks may emphasize earnings more than others. Banks with greater need for earnings might adopt more aggressive lending policies than those that do not consider earnings to be paramount. An aggressive policy might call for making a relatively large amount of term or consumer loans, which normally are made at higher rates of interest than short-term business loans.

The Stability of Deposits

The fluctuation and types of deposits must be considered by a bank in formulating its loan policy. After adequate provisions have been made for the primary and secondary reserves, banks can then engage in lending. Even though these two reserves are designed to take care of predictable deposit fluctuations and loan demands, unpredictable demands force banks to give consideration to the stability of deposits in formulating loan policy.

Economic Conditions
The economic conditions of the area served by a bank are important in demining its loan policy. A stable economy is more conducive to a liberal loan policy than is one that is subject to seasonal and cyclical movements. Deposits of feast or famine economies (weak economies) fluctuate more violently than do deposits in an economy noted for its stability. Consideration must also be given to the national economy. Factors that adversely affect the nation as a whole, if they are of serious magnitude, eventually affect local conditions.

Monetary and Fiscal Policies
The lending ability of banks is also influenced by monetary and fiscal policies. If monetary and fiscal policies are expansionary and additional reserves are made available to the commercial banking system, the lending ability of banks is increased. Under these conditions banks can have more liberal loan policy than if the opposite situation exists.

The Expertise of Banks Personnel
The expertise of lending personnel is not insignificant in the establishment of bank loan policy. For example, officers may have considerable ability and experience in business lending but practically none in making real estate loans, while in other banks their specialty may be consumer lending. One of the probable reasons that banks ere slow in entering consumer lending field is the lack of skilled personnel. Some banks may be so specialized in certain fields of lending that their presence may influence the loan policy of other banks.

The Area Served by Banks
An obvious factor influencing a commercial bank`s loan policy is the area it serves. The major reason banks are chartered is to serve the credit needs of their communities. If this cannot be done, there is little justification for their existence. Banks are morally bound to extend credit to borrowers who present logical and economically sound loan requests. Banks in areas where the economy is predominantly one of cattle raising, for example, cannot turn their back on this type of lending , but should tailor policy to fit the needs of this economic activity.

The Tools Commercial Lenders Need and Use
A good exercise to demonstrate one of the most important tasks that commercial lenders have to do and one that pulls together the various tools they need is to practice writing a credit memo. Seven keys in preparing such memoranda are:

1. Be brief
2. Interpret the information
3. Concentrate on facts
4. Put yourself in the role of the user
5. Maintain a “big picture” perspective
6. Understand the risk (of Business and Banking)
7. Focus on understanding how the business functions

Given these points, credit memos need to address four key areas:

Management: (who are you lending to) important areas to analyse here include stability, past performance, depth, reputation, planning (e.g. projected performance of the company), and strengths and weakness.

Company Operations: ( what do they do and how do they do it?) important areas to analyse here include definition of market ( product and geographic) , structure of the industry, the four Ps of marketing( product, price, promotion and place) and how they relate to the market and industry , degree of competition and substitutes and basic operations of the business.

Industry: (what does the company face?) important areas to analyse here include structure (e.g. cyclical, seasonal, ease of entry /exit, regulated, unionized, etc), description of the industry, company`s position within the industry, position on the product life cycle, industry trends, future concerns and external concerns.

Financial performance: (Quantitative ability to repay?) important areas to analyse here include interpretation of the numbers, analysis and reflections of financial statements ( balance sheet, income-expense, cash flow), understanding trends and changes and how change in financial performance affects business risk. Successful commercial lenders need good communication skills (verbal and written) and, as evidenced by the preceding list, knowledge of finance, accounting, economics, management, marketing and some computer skills.

The Formal Credit Analysis Procedure

The formal credit analysis procedure includes a subjective evalution of the borrower`s request and a detailed review of all financial statements. The loan officer may perform the initial quantitative analysis for the bank manger. The process consists of:

1. Collecting information for the credit file; such as credit history and performance
2. Evaluation management, the company and the industry in which it operates, i.e., evaluation of internal and external factors
3. Spreading financial statements i.e. financial statement analysis
4. Projecting the borrower`s cash flow and thus its ability to service the debt
5. Evaluating collateral or the secondary source of repayment
6. Writing a summary analysis and making a recommendation
The credit file contains background information on the borrower, past and present financial statements, pertinent credit reports, and supporting schedules such as an ageing receivables, a breakdown of current inventory and equipment, and a summary of insurance coverage. If the customer is a previous borrower, the file should also contain copies of the past loan agreement , cash flow projections, collateral agreements and security documents, and narrative comments provided by previous loan officers, and lending is determining the customer`s and copies of all correspondence with the customer. One of the most important aspects of lending is determining the customer`s desire to repay the loan. Although this is critically important it is difficult to measure. Information in the credit file will give the credit officer information on the customer`s repayment history.

The credit analyst also uses the credit file data to spread the financial statements , project cash flow and evaluate collateral. An evaluation of management, the company, and industry is also needed to ensure safety and soundness of the loan. The last step is to submit a written report summarizing the loan request, loan purpose, and the borrower’s comparative financial performance with industry standards, and to make a recommendation. The loan officer evaluates the report and discusses and errors omissions, and extensions with the analyst.

Structuring A Credit Proposal

The following are the key issues to be subject matter of discussion in a credit proposal:

1. Purpose: The purpose of financing sets the main parameters for designing the credit structure, because it affects the safety of repayment and earrings from the business. The proposal should be bankable. The following proposals are relevant for the purpose: [The Indian Institute of Bankers, 2003].

*Compliance of bank`s internal policy (for example financing for preferred sector and sun rise industries).
• The commercial and economic logic of the purpose to be financed.
• The ability and experience of management to handle the proposed venture.
• Compliance with bank`s legal requirements.
• Legal complications arising from the purpose of the financing which may impair the creditworthiness of the advance.

2. Amount: Is it adequate for the purpose? The loan should be need-based, not more and not less. A bank which lends inadequately not caring how the balance requirement will be funded may create problem for itself as well as for the customer.
3. Margin contribution: This is the stake of the proponent in the project. In project lending secured by fixed assets, a cash contribution from the company itself acts as evidence of commitment and cushion to the lenders against failure of the secured assets to generate repayment. In unsecured transactions the focus shifts to the financial mix of debt and equity.
4. Portfolio consideration: Bank`s proposed exposure to the relevant corporate group/industry should be considered. It is not advisable to put all eggs in one basket.
5. Credit risk and term: Banks will wish to limit their exposure to individual high risk and long term advances more tightly than to lower risk and short term advances.
6. Yield: Increasingly banks are concerned with maximizing their yield from the use of their balance sheet and the amount lent can be a significant determinant of the overall return forms the deal. The more the spread, the better for the bank.
7. Legal consideration: Whether the company has borrowing power to borrow the amount and the bank to lend it.
8. Repayment: The key issue is how the bank is to be repaid and what is the margin of error if operations deteriorate. The following factors will be looked into in this regard.

• The type of repayment source
• The quality of repayment source
• The currency of income from the repayment source
• Cash flow protection (i.e. the margin of error)
• Financial flexibility ( i.e. the alternative sources of fund to cover shortages)
• Asset protection to cover the bank if cash flow is inadequate
• The need for good documentation

9. Security and quasi-security: Security whether main or collateral is the banker`s protection against non-payment from the primary repayment source. It is the insurance against failure and takes the form of a legally enforceable claim on tangible assets or a third party guarantee. However, unsecured transactions may be acceptable where cash flow protection is generous and reliable and adequate asset cover is available through the recourse available for genera creditors of the company.
10. Control and Monitoring: The ability to take control of lending situation, before deterioration in borrower`s condition becomes terminal, is crucial. It is achieved by insertion in the documentation of provisions which if breached, will enable the bank to switch over form term facility to one immediately repayable on demand.
11. Designing Credit Faculties: Designing the details of credit facilities within the broad parameters of benefits to the borrower and protection and remuneration for the bank which broadly involves:

• Fixing up cash credit and working capital demand loan limits
• Bills purchase and / or discounting facilities
• Term loan/ deferred payment facilities
• Contingent liabilities limits for LCs and Guarantees

12. Pricing: This is a very important aspect of lending especially in a competitive environment for achieving satisfactory remuneration for the bank. Pricing is based on the directives issued by the central bank from time to time and the market rates. It will consider:

• The risk-reward ratio
• The cost of administration and overheads
• Capital adequacy cost and cost of statutory reserves
• The need to optimize yields on investments

10
The following information may be useful to students of Banking and Financial Markets and Institutions. They are also required to read other Text Books and References.

BANKS`s Loan Policies

Factors that Influence a Bank’s Loan Policies

The restrictions imposed by statutory law and administrative regulations do not provide answer to many questions regarding safe, sound and profitable bank lending, questions regarding the size of the loan portfolio, desirable loan maturities, and the types of loans to be made are unanswered. These questions and many others about lending must be answered by each individual bank. Many banks have developed formal, written lending policies in recent years. Although written lending policies serve a number of purposes, the most important is that they provide guidance for lending officers and thereby establish a greater degree of uniformity in lending practices. Since lending is important both to the bank and to the community it serves, loan policies must be worked out carefully after considering many factors. For the most part, these same factors determine the size and composition of the secondary reserve and the investment account of a bank. Some of the very important factors are mentioned here and discussed only briefly:


1. Capital position
2. Risk and profitability of various types of loans
3. Stability of deposits
4. Economic Conditions
5. Influence of monetary and fiscal policy
6. Ability and experience of bank personnel
7. Credit needs of the area served

Capital Position

The Capital of a bank serves as a cushion for the protection of the depositor`s funds. The size of the capital in relation to deposits influences the amount of risk that a bank can afford to take. Banks with a relatively large capital structure can make loans of longer maturities and greater credit risk.

Risks and Profitability of Different Types of Loan
Since earnings are necessary for the successful operation of a bank, all banks consider this important factor in formulating loan policy. Some banks may emphasize earnings more than others. Banks with greater need for earnings might adopt more aggressive lending policies than those that do not consider earnings to be paramount. An aggressive policy might call for making a relatively large amount of term or consumer loans, which normally are made at higher rates of interest than short-term business loans.

The Stability of Deposits

The fluctuation and types of deposits must be considered by a bank in formulating its loan policy. After adequate provisions have been made for the primary and secondary reserves, banks can then engage in lending. Even though these two reserves are designed to take care of predictable deposit fluctuations and loan demands, unpredictable demands force banks to give consideration to the stability of deposits in formulating loan policy.

Economic Conditions
The economic conditions of the area served by a bank are important in demining its loan policy. A stable economy is more conducive to a liberal loan policy than is one that is subject to seasonal and cyclical movements. Deposits of feast or famine economies (weak economies) fluctuate more violently than do deposits in an economy noted for its stability. Consideration must also be given to the national economy. Factors that adversely affect the nation as a whole, if they are of serious magnitude, eventually affect local conditions.

Monetary and Fiscal Policies
The lending ability of banks is also influenced by monetary and fiscal policies. If monetary and fiscal policies are expansionary and additional reserves are made available to the commercial banking system, the lending ability of banks is increased. Under these conditions banks can have more liberal loan policy than if the opposite situation exists.

The Expertise of Banks Personnel
The expertise of lending personnel is not insignificant in the establishment of bank loan policy. For example, officers may have considerable ability and experience in business lending but practically none in making real estate loans, while in other banks their specialty may be consumer lending. One of the probable reasons that banks ere slow in entering consumer lending field is the lack of skilled personnel. Some banks may be so specialized in certain fields of lending that their presence may influence the loan policy of other banks.

The Area Served by Banks
An obvious factor influencing a commercial bank`s loan policy is the area it serves. The major reason banks are chartered is to serve the credit needs of their communities. If this cannot be done, there is little justification for their existence. Banks are morally bound to extend credit to borrowers who present logical and economically sound loan requests. Banks in areas where the economy is predominantly one of cattle raising, for example, cannot turn their back on this type of lending , but should tailor policy to fit the needs of this economic activity.

The Tools Commercial Lenders Need and Use
A good exercise to demonstrate one of the most important tasks that commercial lenders have to do and one that pulls together the various tools they need is to practice writing a credit memo. Seven keys in preparing such memoranda are:

1. Be brief
2. Interpret the information
3. Concentrate on facts
4. Put yourself in the role of the user
5. Maintain a “big picture” perspective
6. Understand the risk (of Business and Banking)
7. Focus on understanding how the business functions

Given these points, credit memos need to address four key areas:

Management: (who are you lending to) important areas to analyse here include stability, past performance, depth, reputation, planning (e.g. projected performance of the company), and strengths and weakness.

Company Operations: ( what do they do and how do they do it?) important areas to analyse here include definition of market ( product and geographic) , structure of the industry, the four Ps of marketing( product, price, promotion and place) and how they relate to the market and industry , degree of competition and substitutes and basic operations of the business.

Industry: (what does the company face?) important areas to analyse here include structure (e.g. cyclical, seasonal, ease of entry /exit, regulated, unionized, etc), description of the industry, company`s position within the industry, position on the product life cycle, industry trends, future concerns and external concerns.

Financial performance: (Quantitative ability to repay?) important areas to analyse here include interpretation of the numbers, analysis and reflections of financial statements ( balance sheet, income-expense, cash flow), understanding trends and changes and how change in financial performance affects business risk. Successful commercial lenders need good communication skills (verbal and written) and, as evidenced by the preceding list, knowledge of finance, accounting, economics, management, marketing and some computer skills.

The Formal Credit Analysis Procedure

The formal credit analysis procedure includes a subjective evalution of the borrower`s request and a detailed review of all financial statements. The loan officer may perform the initial quantitative analysis for the bank manger. The process consists of:

1. Collecting information for the credit file; such as credit history and performance
2. Evaluation management, the company and the industry in which it operates, i.e., evaluation of internal and external factors
3. Spreading financial statements i.e. financial statement analysis
4. Projecting the borrower`s cash flow and thus its ability to service the debt
5. Evaluating collateral or the secondary source of repayment
6. Writing a summary analysis and making a recommendation
The credit file contains background information on the borrower, past and present financial statements, pertinent credit reports, and supporting schedules such as an ageing receivables, a breakdown of current inventory and equipment, and a summary of insurance coverage. If the customer is a previous borrower, the file should also contain copies of the past loan agreement , cash flow projections, collateral agreements and security documents, and narrative comments provided by previous loan officers, and lending is determining the customer`s and copies of all correspondence with the customer. One of the most important aspects of lending is determining the customer`s desire to repay the loan. Although this is critically important it is difficult to measure. Information in the credit file will give the credit officer information on the customer`s repayment history.

The credit analyst also uses the credit file data to spread the financial statements , project cash flow and evaluate collateral. An evaluation of management, the company, and industry is also needed to ensure safety and soundness of the loan. The last step is to submit a written report summarizing the loan request, loan purpose, and the borrower’s comparative financial performance with industry standards, and to make a recommendation. The loan officer evaluates the report and discusses and errors omissions, and extensions with the analyst.

Structuring A Credit Proposal

The following are the key issues to be subject matter of discussion in a credit proposal:

1. Purpose: The purpose of financing sets the main parameters for designing the credit structure, because it affects the safety of repayment and earrings from the business. The proposal should be bankable. The following proposals are relevant for the purpose: [The Indian Institute of Bankers, 2003].

*Compliance of bank`s internal policy (for example financing for preferred sector and sun rise industries).
• The commercial and economic logic of the purpose to be financed.
• The ability and experience of management to handle the proposed venture.
• Compliance with bank`s legal requirements.
• Legal complications arising from the purpose of the financing which may impair the creditworthiness of the advance.

2. Amount: Is it adequate for the purpose? The loan should be need-based, not more and not less. A bank which lends inadequately not caring how the balance requirement will be funded may create problem for itself as well as for the customer.
3. Margin contribution: This is the stake of the proponent in the project. In project lending secured by fixed assets, a cash contribution from the company itself acts as evidence of commitment and cushion to the lenders against failure of the secured assets to generate repayment. In unsecured transactions the focus shifts to the financial mix of debt and equity.
4. Portfolio consideration: Bank`s proposed exposure to the relevant corporate group/industry should be considered. It is not advisable to put all eggs in one basket.
5. Credit risk and term: Banks will wish to limit their exposure to individual high risk and long term advances more tightly than to lower risk and short term advances.
6. Yield: Increasingly banks are concerned with maximizing their yield from the use of their balance sheet and the amount lent can be a significant determinant of the overall return forms the deal. The more the spread, the better for the bank.
7. Legal consideration: Whether the company has borrowing power to borrow the amount and the bank to lend it.
8. Repayment: The key issue is how the bank is to be repaid and what is the margin of error if operations deteriorate. The following factors will be looked into in this regard.

• The type of repayment source
• The quality of repayment source
• The currency of income from the repayment source
• Cash flow protection (i.e. the margin of error)
• Financial flexibility ( i.e. the alternative sources of fund to cover shortages)
• Asset protection to cover the bank if cash flow is inadequate
• The need for good documentation

9. Security and quasi-security: Security whether main or collateral is the banker`s protection against non-payment from the primary repayment source. It is the insurance against failure and takes the form of a legally enforceable claim on tangible assets or a third party guarantee. However, unsecured transactions may be acceptable where cash flow protection is generous and reliable and adequate asset cover is available through the recourse available for genera creditors of the company.
10. Control and Monitoring: The ability to take control of lending situation, before deterioration in borrower`s condition becomes terminal, is crucial. It is achieved by insertion in the documentation of provisions which if breached, will enable the bank to switch over form term facility to one immediately repayable on demand.
11. Designing Credit Faculties: Designing the details of credit facilities within the broad parameters of benefits to the borrower and protection and remuneration for the bank which broadly involves:

• Fixing up cash credit and working capital demand loan limits
• Bills purchase and / or discounting facilities
• Term loan/ deferred payment facilities
• Contingent liabilities limits for LCs and Guarantees

12. Pricing: This is a very important aspect of lending especially in a competitive environment for achieving satisfactory remuneration for the bank. Pricing is based on the directives issued by the central bank from time to time and the market rates. It will consider:

• The risk-reward ratio
• The cost of administration and overheads
• Capital adequacy cost and cost of statutory reserves
• The need to optimize yields on investments

11
Financial Development and Real Development : Some Observations

Several empirical studies have confirmed that there is a strong link between financial development and economic growth. Countries with well-developed banking system and capital markets tend to enjoy faster growth than those without. A study by Rosel Levine and Sara Zervos examined forty seven countries from 1976 to1993. They found that stock market liquidity (the value of shares traded relative to stock market capitalization) and the size of the banking sector ( measured by the lending to the private sector as a percentage of GDP ) are good predictors of future rate of growth, even after controlling for other factors, such as initial level of income, education and political stability.

In rich economies, the assets of financial intermediaries and the size of the stock and bond markets all tend to be bigger in relation to GDP than in poor ones. In emerging economies, banking system is quick to develop, but capital markets take longer; because capital market need a financial infrastructure that provides, among other things, adequate accounting standards, a legal system that enforces contracts and protects property rights, and bankruptcy provisions.

However, the relationship between the real and financial components of the development process is, to a large extent, influenced by a large number of factors. They include factors affecting financial growth whose relationship with economic development is very difficult to pinpoint, for example, the degree of centralization of the economy, international relations, methods of financing public debt and the existence of acute or chronic inflation. Another set of factors which affect the structure and modus operandi of the economy and financial system include the subsistence nature of the economy, the degree of sectoral and spatial diversification, pattern and level of urban consumption compared with average disposable income, prevailing habits and forms of savings by economic agents. Although, the fundamental dynamics of development lie outside the banking system, the way the system is structured can either significantly hasten or retard development.

It must be remembered that the method of operation of the financial institutions and the way in which agents and functions are specialized depend to a large extent on the characteristic of each country, especially it’s policy guide lines, relation between the public and private sector as regards financial matters and the level of openness or self financing of the dominant enterprises.

One aspect of financial development which has drawn attention of economists and bankers is the phenomena of financial repression and financial liberalization.

Financial repression and financial liberalization

The formal banking and financial sector is repressed primarily by interest rate ceilings that are particularly binding when inflation is high and artificially low loan rates create an excess demand for loan able funds that may be rationed through favoritism to licensed importers, large scale exporters, protected manufacturers and government agencies. Unfavored enterprises are excluded from the long term finance of the formal banks and left to borrow at much higher rates from the informal financial sector of local money lenders, landlords, pawnbrokers etc. McKinnon makes this point clear by citing a truly alarming difference between official and unofficial lending rates in Ethiopia 6 to 9 percent versus 100 to 200 percent [McKinnon, Ronald I, 1973]. This is true for many other developing countries of Asia, Africa, and Latin America. Extending the usury ceiling to the informal sector by the government does not remedy the problem, but worsens it by making credit still less available.

The remedy lies in eliminating financial repression so that bank intermediated funding becomes available to the entrepreneur throughout the economy. With free entry into banking, the money lender can transform their own operations into formal or quasi formal banks.

In fact monetary and financial regulatory policies that stifle domestic intermediation, creating “financial repression” are primarily responsible for poorly functioning domestic monetary system and capital markets and thus for poor growth. Interest rate ceilings on deposits and loans, combined with inflationary rates of monetary expansion, are the most important policies creating financial repression.

In developing countries, there is considerable debate about the desirability of moving away from controlled economic order and toward a more liberal one. Financial market liberalization refers to decontrol of interest rates, the removal of exchange controls, the exchange rate float, the abolition of ration requirements etc.

According to Shaw [Shaw, Edward.S., 1986] financial liberalization (reforms) brings the following benefits to an economy:

(a) It tends to raise the ratios of private domestic savings to income.
(b) It permits the financial process of mobilizing and allocating savings to displace in some degree the fiscal process, inflation and foreign aid.
(c) It opens the way to superior allocations of savings by widening and diversifying the financial markets on which investment opportunities compete for the savings flow. Financial liberalization and financial deepening contribute to the stability and growth of output and employment.

Once an economy is sufficiently financially liberalized, these benefits ensue, whereas in a financially repressed economy, prices are distorted due to interventionist policy of the government. It is argued that piece meal reforms may not achieve the objectives for which reform measures are adopted [Mckinno, Ronald I,1986]. Where financial reforms have been successful, it involved complete or near complete removal of controls in favor of market generated solutions.

Money and Capital Markets:
The components of financial markets of developed countries can be roughly grouped into money and capital markets. Money markets are a source of short term financing. They have developed in response to the needs of governments, financial institutions and business for ready access to a supply of cash to meet immediate needs and a place to put cash temporarily. The financial instruments used in money market include government securities, commercial papers, certificates of deposits and bankers acceptances etc. Banks were the only formal institutions participating in the money markets, but there has been a significant increase over the years in the number of mutual funds and dealers that invest and trade in the money market.

Capital markets exist to provide long term financing for start up and expanding enterprises. Financing is obtained in the capital markets either by issuing debt instruments, typically bonds, or by selling equity in the enterprise through the sale of shares.

The sources of funds in the capital markets fall into two categories, non securities and securities, depending upon whether or not the financial instruments used to document the financial arrangement is transferable, that is negotiable. The securities component of capital market provide long term equity and loan funds through the use of negotiable instruments that can be highly effective in mobilizing domestic capital because the securities representing the investments can be readily sold to meet cash needs or other investment objectives.

The Securities segment of capital market consists of primary and secondary markets both of which are essential in attracting savings to investment. Companies obtain financing for the acquisition of the plant and equipment needed for production by issuing securities in the primary market. In developed countries, these securities are not generally sold directly to the public by issuers, but instead are distributed by brokers or purchased by underwriters for subsequent resale to institutional and individual investors. In this connection the establishment of a stock exchange is of utmost importance. It is the secondary market that assures liquidity to investor in both markets.

But the growth of capital and equity markets in most LDCs is retarded by the lack of requisite conditions for the development of private enterprise. As a result, the number, volume, and variety of stock traded in LDC equity markets are small and sometimes even these sparse markets are dominated by government debt securities. Of course, the corollary of such limited supply is the scarcity of the investors in these markets and limited volume of transactions. Therefore the equity raised through new public issue is not very significant relative to gross national product or to the value of funds channeled to the private sector through the non securities markets i.e. financial institutions. In view of the above, governments in LDCs should make all endeavor to develop a capital and equity market.

Capital and Equity Markets: Developmental and Regulatory Considerations

There is a growing recognition amount the government of developing countries that the expansion of the role of the private sector in economic development is a prerequisite for sustained economic growth and that equity markets play a crucial role in financing the growth in private investment. As a result many developing countries are putting increasing emphasis on the development of their capital markets. Therefore, a brief discussion on the problems of the issue of developing a capital and equity market is given below.

Capital and equity markets have to face the following problems:

Lack of unified government office to supervise and develop the market: In many developing countries, responsibility for the supervision and development of the capital market is segmented among different government agencies whose role may overlap or conflict and result in extensive duplicative and sometimes in consistent regulations.

Scarcity of adequate skills: Often regulatory staff does not have the requisite skills to conduct regulatory work or to promote the development of the securities markets.

Insufficient understanding of the markets: In many countries, existing regulatory bodies are run by officials and civil servants who have knowledge of regulation but lack knowledge of how a market works and what will make it grow. Generally, there are few practitioners with the real understanding of how security market operates.

Lack of authority to enforce regulations: Some times, even if they have qualified personnel, existing bodies often do not have enough authority to enforce rules or to promote regulations to develop the market.

Over emphasis on regulations and under emphasis on development: A common problem in securities market development is that too much emphasis is put on regulation and little on market development. It is essential not to divorce the objective of developing capital markets from the objective of regulating them [Berril, Sir, Kenneth, 1986]. Experience shows that countries such as Brazil and Korea, that had taken a developmental approach to capital market growth while at the same time attending to regulation have been more successful in their effort to develop the market.
The government should take appropriate measures to remedy the above problems for the development of capital and equity markets.
The development of a country`s capital and equity markets will only occur as a part of a comprehensive endeavor that addresses all the factors that affect the profitability and attractiveness of private enterprise for individuals. Capital and equity markets can develop and flourish only in market economies. But a free market is not sufficient for the successful development of a capital and equity market. Other factors including conditions of political instability and social turmoil or inadequate and restrictive laws and regulations also increase risk of investment. The challenge is to attain a delicate balance between a system that assures the adequate protection of the investors and one that does not deter market growth.

Professor Rafiqul Islam
Dept. of Business Administration
Daffodil International University

12
Financial Development and Real Development : Some Observations

Several empirical studies have confirmed that there is a strong link between financial development and economic growth. Countries with well-developed banking system and capital markets tend to enjoy faster growth than those without. A study by Rosel Levine and Sara Zervos examined forty seven countries from 1976 to1993. They found that stock market liquidity (the value of shares traded relative to stock market capitalization) and the size of the banking sector ( measured by the lending to the private sector as a percentage of GDP ) are good predictors of future rate of growth, even after controlling for other factors, such as initial level of income, education and political stability.

In rich economies, the assets of financial intermediaries and the size of the stock and bond markets all tend to be bigger in relation to GDP than in poor ones. In emerging economies, banking system is quick to develop, but capital markets take longer; because capital market need a financial infrastructure that provides, among other things, adequate accounting standards, a legal system that enforces contracts and protects property rights, and bankruptcy provisions.

However, the relationship between the real and financial components of the development process is, to a large extent, influenced by a large number of factors. They include factors affecting financial growth whose relationship with economic development is very difficult to pinpoint, for example, the degree of centralization of the economy, international relations, methods of financing public debt and the existence of acute or chronic inflation. Another set of factors which affect the structure and modus operandi of the economy and financial system include the subsistence nature of the economy, the degree of sectoral and spatial diversification, pattern and level of urban consumption compared with average disposable income, prevailing habits and forms of savings by economic agents. Although, the fundamental dynamics of development lie outside the banking system, the way the system is structured can either significantly hasten or retard development.

It must be remembered that the method of operation of the financial institutions and the way in which agents and functions are specialized depend to a large extent on the characteristic of each country, especially it’s policy guide lines, relation between the public and private sector as regards financial matters and the level of openness or self financing of the dominant enterprises.

One aspect of financial development which has drawn attention of economists and bankers is the phenomena of financial repression and financial liberalization.

Financial repression and financial liberalization

The formal banking and financial sector is repressed primarily by interest rate ceilings that are particularly binding when inflation is high and artificially low loan rates create an excess demand for loan able funds that may be rationed through favoritism to licensed importers, large scale exporters, protected manufacturers and government agencies. Unfavored enterprises are excluded from the long term finance of the formal banks and left to borrow at much higher rates from the informal financial sector of local money lenders, landlords, pawnbrokers etc. McKinnon makes this point clear by citing a truly alarming difference between official and unofficial lending rates in Ethiopia 6 to 9 percent versus 100 to 200 percent [McKinnon, Ronald I, 1973]. This is true for many other developing countries of Asia, Africa, and Latin America. Extending the usury ceiling to the informal sector by the government does not remedy the problem, but worsens it by making credit still less available.

The remedy lies in eliminating financial repression so that bank intermediated funding becomes available to the entrepreneur throughout the economy. With free entry into banking, the money lender can transform their own operations into formal or quasi formal banks.

In fact monetary and financial regulatory policies that stifle domestic intermediation, creating “financial repression” are primarily responsible for poorly functioning domestic monetary system and capital markets and thus for poor growth. Interest rate ceilings on deposits and loans, combined with inflationary rates of monetary expansion, are the most important policies creating financial repression.

In developing countries, there is considerable debate about the desirability of moving away from controlled economic order and toward a more liberal one. Financial market liberalization refers to decontrol of interest rates, the removal of exchange controls, the exchange rate float, the abolition of ration requirements etc.

According to Shaw [Shaw, Edward.S., 1986] financial liberalization (reforms) brings the following benefits to an economy:

(a) It tends to raise the ratios of private domestic savings to income.
(b) It permits the financial process of mobilizing and allocating savings to displace in some degree the fiscal process, inflation and foreign aid.
(c) It opens the way to superior allocations of savings by widening and diversifying the financial markets on which investment opportunities compete for the savings flow. Financial liberalization and financial deepening contribute to the stability and growth of output and employment.

Once an economy is sufficiently financially liberalized, these benefits ensue, whereas in a financially repressed economy, prices are distorted due to interventionist policy of the government. It is argued that piece meal reforms may not achieve the objectives for which reform measures are adopted [Mckinno, Ronald I,1986]. Where financial reforms have been successful, it involved complete or near complete removal of controls in favor of market generated solutions.

Money and Capital Markets:
The components of financial markets of developed countries can be roughly grouped into money and capital markets. Money markets are a source of short term financing. They have developed in response to the needs of governments, financial institutions and business for ready access to a supply of cash to meet immediate needs and a place to put cash temporarily. The financial instruments used in money market include government securities, commercial papers, certificates of deposits and bankers acceptances etc. Banks were the only formal institutions participating in the money markets, but there has been a significant increase over the years in the number of mutual funds and dealers that invest and trade in the money market.

Capital markets exist to provide long term financing for start up and expanding enterprises. Financing is obtained in the capital markets either by issuing debt instruments, typically bonds, or by selling equity in the enterprise through the sale of shares.

The sources of funds in the capital markets fall into two categories, non securities and securities, depending upon whether or not the financial instruments used to document the financial arrangement is transferable, that is negotiable. The securities component of capital market provide long term equity and loan funds through the use of negotiable instruments that can be highly effective in mobilizing domestic capital because the securities representing the investments can be readily sold to meet cash needs or other investment objectives.

The Securities segment of capital market consists of primary and secondary markets both of which are essential in attracting savings to investment. Companies obtain financing for the acquisition of the plant and equipment needed for production by issuing securities in the primary market. In developed countries, these securities are not generally sold directly to the public by issuers, but instead are distributed by brokers or purchased by underwriters for subsequent resale to institutional and individual investors. In this connection the establishment of a stock exchange is of utmost importance. It is the secondary market that assures liquidity to investor in both markets.

But the growth of capital and equity markets in most LDCs is retarded by the lack of requisite conditions for the development of private enterprise. As a result, the number, volume, and variety of stock traded in LDC equity markets are small and sometimes even these sparse markets are dominated by government debt securities. Of course, the corollary of such limited supply is the scarcity of the investors in these markets and limited volume of transactions. Therefore the equity raised through new public issue is not very significant relative to gross national product or to the value of funds channeled to the private sector through the non securities markets i.e. financial institutions. In view of the above, governments in LDCs should make all endeavor to develop a capital and equity market.

Capital and Equity Markets: Developmental and Regulatory Considerations

There is a growing recognition amount the government of developing countries that the expansion of the role of the private sector in economic development is a prerequisite for sustained economic growth and that equity markets play a crucial role in financing the growth in private investment. As a result many developing countries are putting increasing emphasis on the development of their capital markets. Therefore, a brief discussion on the problems of the issue of developing a capital and equity market is given below.

Capital and equity markets have to face the following problems:

Lack of unified government office to supervise and develop the market: In many developing countries, responsibility for the supervision and development of the capital market is segmented among different government agencies whose role may overlap or conflict and result in extensive duplicative and sometimes in consistent regulations.

Scarcity of adequate skills: Often regulatory staff does not have the requisite skills to conduct regulatory work or to promote the development of the securities markets.

Insufficient understanding of the markets: In many countries, existing regulatory bodies are run by officials and civil servants who have knowledge of regulation but lack knowledge of how a market works and what will make it grow. Generally, there are few practitioners with the real understanding of how security market operates.

Lack of authority to enforce regulations: Some times, even if they have qualified personnel, existing bodies often do not have enough authority to enforce rules or to promote regulations to develop the market.

Over emphasis on regulations and under emphasis on development: A common problem in securities market development is that too much emphasis is put on regulation and little on market development. It is essential not to divorce the objective of developing capital markets from the objective of regulating them [Berril, Sir, Kenneth, 1986]. Experience shows that countries such as Brazil and Korea, that had taken a developmental approach to capital market growth while at the same time attending to regulation have been more successful in their effort to develop the market.
The government should take appropriate measures to remedy the above problems for the development of capital and equity markets.
The development of a country`s capital and equity markets will only occur as a part of a comprehensive endeavor that addresses all the factors that affect the profitability and attractiveness of private enterprise for individuals. Capital and equity markets can develop and flourish only in market economies. But a free market is not sufficient for the successful development of a capital and equity market. Other factors including conditions of political instability and social turmoil or inadequate and restrictive laws and regulations also increase risk of investment. The challenge is to attain a delicate balance between a system that assures the adequate protection of the investors and one that does not deter market growth.

Professor Rafiqul Islam
Dept. of Business Administration
Daffodil International University

13
Financial Development and Real Development : Some Observations

Several empirical studies have confirmed that there is a strong link between financial development and economic growth. Countries with well-developed banking system and capital markets tend to enjoy faster growth than those without. A study by Rosel Levine and Sara Zervos examined forty seven countries from 1976 to1993. They found that stock market liquidity (the value of shares traded relative to stock market capitalization) and the size of the banking sector ( measured by the lending to the private sector as a percentage of GDP ) are good predictors of future rate of growth, even after controlling for other factors, such as initial level of income, education and political stability.

In rich economies, the assets of financial intermediaries and the size of the stock and bond markets all tend to be bigger in relation to GDP than in poor ones. In emerging economies, banking system is quick to develop, but capital markets take longer; because capital market need a financial infrastructure that provides, among other things, adequate accounting standards, a legal system that enforces contracts and protects property rights, and bankruptcy provisions.

However, the relationship between the real and financial components of the development process is, to a large extent, influenced by a large number of factors. They include factors affecting financial growth whose relationship with economic development is very difficult to pinpoint, for example, the degree of centralization of the economy, international relations, methods of financing public debt and the existence of acute or chronic inflation. Another set of factors which affect the structure and modus operandi of the economy and financial system include the subsistence nature of the economy, the degree of sectoral and spatial diversification, pattern and level of urban consumption compared with average disposable income, prevailing habits and forms of savings by economic agents. Although, the fundamental dynamics of development lie outside the banking system, the way the system is structured can either significantly hasten or retard development.

It must be remembered that the method of operation of the financial institutions and the way in which agents and functions are specialized depend to a large extent on the characteristic of each country, especially it’s policy guide lines, relation between the public and private sector as regards financial matters and the level of openness or self financing of the dominant enterprises.

One aspect of financial development which has drawn attention of economists and bankers is the phenomena of financial repression and financial liberalization.

Financial repression and financial liberalization

The formal banking and financial sector is repressed primarily by interest rate ceilings that are particularly binding when inflation is high and artificially low loan rates create an excess demand for loan able funds that may be rationed through favoritism to licensed importers, large scale exporters, protected manufacturers and government agencies. Unfavored enterprises are excluded from the long term finance of the formal banks and left to borrow at much higher rates from the informal financial sector of local money lenders, landlords, pawnbrokers etc. McKinnon makes this point clear by citing a truly alarming difference between official and unofficial lending rates in Ethiopia 6 to 9 percent versus 100 to 200 percent [McKinnon, Ronald I, 1973]. This is true for many other developing countries of Asia, Africa, and Latin America. Extending the usury ceiling to the informal sector by the government does not remedy the problem, but worsens it by making credit still less available.

The remedy lies in eliminating financial repression so that bank intermediated funding becomes available to the entrepreneur throughout the economy. With free entry into banking, the money lender can transform their own operations into formal or quasi formal banks.

In fact monetary and financial regulatory policies that stifle domestic intermediation, creating “financial repression” are primarily responsible for poorly functioning domestic monetary system and capital markets and thus for poor growth. Interest rate ceilings on deposits and loans, combined with inflationary rates of monetary expansion, are the most important policies creating financial repression.

In developing countries, there is considerable debate about the desirability of moving away from controlled economic order and toward a more liberal one. Financial market liberalization refers to decontrol of interest rates, the removal of exchange controls, the exchange rate float, the abolition of ration requirements etc.

According to Shaw [Shaw, Edward.S., 1986] financial liberalization (reforms) brings the following benefits to an economy:

(a) It tends to raise the ratios of private domestic savings to income.
(b) It permits the financial process of mobilizing and allocating savings to displace in some degree the fiscal process, inflation and foreign aid.
(c) It opens the way to superior allocations of savings by widening and diversifying the financial markets on which investment opportunities compete for the savings flow. Financial liberalization and financial deepening contribute to the stability and growth of output and employment.

Once an economy is sufficiently financially liberalized, these benefits ensue, whereas in a financially repressed economy, prices are distorted due to interventionist policy of the government. It is argued that piece meal reforms may not achieve the objectives for which reform measures are adopted [Mckinno, Ronald I,1986]. Where financial reforms have been successful, it involved complete or near complete removal of controls in favor of market generated solutions.

Money and Capital Markets:
The components of financial markets of developed countries can be roughly grouped into money and capital markets. Money markets are a source of short term financing. They have developed in response to the needs of governments, financial institutions and business for ready access to a supply of cash to meet immediate needs and a place to put cash temporarily. The financial instruments used in money market include government securities, commercial papers, certificates of deposits and bankers acceptances etc. Banks were the only formal institutions participating in the money markets, but there has been a significant increase over the years in the number of mutual funds and dealers that invest and trade in the money market.

Capital markets exist to provide long term financing for start up and expanding enterprises. Financing is obtained in the capital markets either by issuing debt instruments, typically bonds, or by selling equity in the enterprise through the sale of shares.

The sources of funds in the capital markets fall into two categories, non securities and securities, depending upon whether or not the financial instruments used to document the financial arrangement is transferable, that is negotiable. The securities component of capital market provide long term equity and loan funds through the use of negotiable instruments that can be highly effective in mobilizing domestic capital because the securities representing the investments can be readily sold to meet cash needs or other investment objectives.

The Securities segment of capital market consists of primary and secondary markets both of which are essential in attracting savings to investment. Companies obtain financing for the acquisition of the plant and equipment needed for production by issuing securities in the primary market. In developed countries, these securities are not generally sold directly to the public by issuers, but instead are distributed by brokers or purchased by underwriters for subsequent resale to institutional and individual investors. In this connection the establishment of a stock exchange is of utmost importance. It is the secondary market that assures liquidity to investor in both markets.

But the growth of capital and equity markets in most LDCs is retarded by the lack of requisite conditions for the development of private enterprise. As a result, the number, volume, and variety of stock traded in LDC equity markets are small and sometimes even these sparse markets are dominated by government debt securities. Of course, the corollary of such limited supply is the scarcity of the investors in these markets and limited volume of transactions. Therefore the equity raised through new public issue is not very significant relative to gross national product or to the value of funds channeled to the private sector through the non securities markets i.e. financial institutions. In view of the above, governments in LDCs should make all endeavor to develop a capital and equity market.

Capital and Equity Markets: Developmental and Regulatory Considerations

There is a growing recognition amount the government of developing countries that the expansion of the role of the private sector in economic development is a prerequisite for sustained economic growth and that equity markets play a crucial role in financing the growth in private investment. As a result many developing countries are putting increasing emphasis on the development of their capital markets. Therefore, a brief discussion on the problems of the issue of developing a capital and equity market is given below.

Capital and equity markets have to face the following problems:

Lack of unified government office to supervise and develop the market: In many developing countries, responsibility for the supervision and development of the capital market is segmented among different government agencies whose role may overlap or conflict and result in extensive duplicative and sometimes in consistent regulations.

Scarcity of adequate skills: Often regulatory staff does not have the requisite skills to conduct regulatory work or to promote the development of the securities markets.

Insufficient understanding of the markets: In many countries, existing regulatory bodies are run by officials and civil servants who have knowledge of regulation but lack knowledge of how a market works and what will make it grow. Generally, there are few practitioners with the real understanding of how security market operates.

Lack of authority to enforce regulations: Some times, even if they have qualified personnel, existing bodies often do not have enough authority to enforce rules or to promote regulations to develop the market.

Over emphasis on regulations and under emphasis on development: A common problem in securities market development is that too much emphasis is put on regulation and little on market development. It is essential not to divorce the objective of developing capital markets from the objective of regulating them [Berril, Sir, Kenneth, 1986]. Experience shows that countries such as Brazil and Korea, that had taken a developmental approach to capital market growth while at the same time attending to regulation have been more successful in their effort to develop the market.
The government should take appropriate measures to remedy the above problems for the development of capital and equity markets.
The development of a country`s capital and equity markets will only occur as a part of a comprehensive endeavor that addresses all the factors that affect the profitability and attractiveness of private enterprise for individuals. Capital and equity markets can develop and flourish only in market economies. But a free market is not sufficient for the successful development of a capital and equity market. Other factors including conditions of political instability and social turmoil or inadequate and restrictive laws and regulations also increase risk of investment. The challenge is to attain a delicate balance between a system that assures the adequate protection of the investors and one that does not deter market growth.

Professor Rafiqul Islam
Dept. of Business Administration
Daffodil International University

14
For students of Finance and Banking
The Application of Monetary Policy: Rules, Discretion & Central Bank’s Autonomy

The debate about whether monetary policy decisions should be governed by rules or discretion has a long history. However, neither pure discretion nor fixed adherence to an intermediate monetary target has proved satisfactory. In their place several countries are moving toward a regime in which there is a clear target for the ultimate objective of monetary policy, together with a statement of the authorities decision making practices that is as open and transparent as possible.

We notice three broad phases in the approach to policy making in the postwar period. Until about the late 1960s, it was taken for granted, that formulating monetary policy required a substantial amount of discretion. From the early 1970s until the 1980s, there was a growing emphasis on rules. By the late 1980s; however, there was a swing away from rule based policy regimes. The relationship between intermediate targets and ultimate objectives became more variable under the influence of financial liberalization and innovation. In recent years it seems most central banks have recognized the need for a return to greater discretion in the use of monetary instruments.

In this context, it is necessary to provide the definition of a few terms, because the same expressions may be used to mean different things by different authors. Central banks use policy instruments to pursue ultimate policy objectives. Along the way, they are concerned with intermediate variables which are part of the policy transmission process as well as with indicator variables, which may provide information about the impact of policy, without themselves being part of the transmission mechanism.
Rules are generally taken to require the authorities to use the instruments of monetary policy to achieve a given predetermined path for an intermediate variable (usually a monetary aggregate). Intermediate variables are those which the, monetary authorities may attempt to target because of their presumed relationship with the ultimate objectives of monetary policy. The most common example of an intermediate variable is the money stock or credit stock. To the extent that growth in monetary aggregates is stably related to the ultimate objective of monetary policy (the steady growth of the nominal value of output) and to the extent that it is more feasible to control the money stock than nominal output, it makes sense to direct policy instruments towards the achievement of an intermediate variable.

Indicator variables can be defined as those that have information value about the impact of instrument on policy outcomes but are not themselves an object of control. In fact the whole range of economic quantities has a bearing on monetary policy decisions. They can include variables that in another context may be viewed as intermediate target. For example the growth of money stock can be regarded as object to be controlled. It can also be regarded as one indicator (among others) of the potential strength of demand in the economy. This underlines an important point just because a monetary variable is not used as an object of control does not mean that it does not play an important role in evaluating the stance of monetary policy.

Other indicator variables are those that convey information about the future of the economy, and the balance between inflationary and recessionary forces. They include all variables relating to the current and prospective level of real economic activity [GDP growth, industrial production, retail sales, consumer and business spending surveys, etc.]. They also include cost and price indicators [wages, import costs, consumer and producer price indices] and expectation indices, including expectations derived from financial variables such as the shape of the yield curve.

The distinction between whether variables are to be treated as indicators or intermediate targets is crucial to the distinction between rules and discretion. However, the distinction between rules and discretion is not straightforward, and, hence deserves some clarification.

The use of discretion in monetary policy is clearly not intended to imply randomness in decision making. A discretionary policy action usually reflects a systematic response by policy authorities, taken in the light of their objectives and their perceptions as to how the economy will respond to particular economic stimuli.

Arguments for discretion in the formulation and implementation of policy:

First, economics is subject to both supply shocks and demand shocks. The appropriate monetary policy response will be quite different in the two cases. If the authorities can identify the nature of different shocks, they will be able to improve welfare by exercising discretion in how they respond to them.

A second argument for discretion lies in the fact that the speed with which an economy returns to price stability following an inflationary or deflationary shock has implications for output and employment. The use of discretion may enable the central bank to tolerate some overshooting of the monetary targets to allow the return to price stability to take place in a more orderly manner.

A third argument for discretion is that the structure of the economy is changing through time in ways that cannot easily be predicted in advance. The relationship between intermediate variables and the ultimate objectives of policy can be affected by technical developments. Under such circumstances discretion, rather than a set rules, could be more appropriate.

Arguments for rules
One view is that, in a democracy, discretion from decision making should be removed from individuals and vested in rules and laws. Perhaps the more important economic argument for rule is that there is fundamentally stable relationship between an intermediate variable (a monetary aggregate) and the ultimate objective of monetary policy (the growth of nominal income). The benefits of discretion are, therefore small, since it is not possible to improve much of the outcome generated by adopting a stable money growth target. On the other hand, so the argument goes, the costs of discretion are potentially large

A subsidiary argument for rules is that financial markets operate most efficiently in the presence of certainty. If in addition to the inherent uncertainties generated by outside economic shocks, there are uncertainties about the authorities’ policy response, the difficulties faced by markets will be compounded. This argument has been formalized in the literature on the time consistency problem and the value of rules that pre-commit the authorities to a particular course of action.

The arguments in favor of rules are based more on the quality of discretionary action, than on discretion per se. it may be argued that discretionary monetary policy is subject to two systematic sources of adverse bias: too little, too late. For example, there will be greater willingness to lower interest rates than to raise them.

The Central Bank Independence: Rationale and Reality
One of the primary tenets of accepted central banking thought has been the importance of keeping central banks politically independent. No other aspect of central banking has evoked more attention and discussion than the advocacy of central bank independence of political authority. The concept of an independent central bank separates the power to create money form the power to spend money (vested in the executive). Hence, the strongest argument for an independent central bank rests on the view that subjecting the central bank to more political pressure would impart an inflationary bias to monetary policy. In the view of many observers, politicians in a democratic society are short sighted, because they are driven by the need to win their next election and they are unlikely to focus in long run objectives, such as promoting a stable price level. Instead they will seek short run solutions to problems even if the short run solutions have undesirable long run effects. A politically insulted central bank is more likely to be concerned with long run objectives and thus be a defender of a sound currency and a stable price. Putting the central bank under the control of the government is considered dangerous because the central bank can be used to facilitate financing large budget deficits and thus this help out might lead to a more inflationary bias in the economy. An independent central bank is better able to resist this pressure from government expenditure without raising taxes. An independent central bank largely removed from political pressure is needed to ensure justice to those who lose from inflation.

Another argument for central bank independence is that conduct of monetary policy is too important to leave to politicians who may have lack of expertise at making hard decisions on issues of great economic importance, such as reforming the banking system, or reducing the budget deficit. The crucial parameters like price level and exchange rate under no circumstances should be transferred into political control variable. But the removal of monetary policy form the political sphere is itself a political act. There seems to be an even stronger case for independent central bank in the developing countries given the greater frequency and arbitrariness of political change coupled with the politicization of finance .Recent research demonstrates that political instability causes instability at the central bank too, although the spillover varies across countries and type of political traditions. These are hard question which have not been addressed in the debate on central bank independence.

The Case against Independence of Central Bank
Proponents of control of central bank by government argue that it is undemocratic to have monetary policy (which affects everyone in the economy) formulated by an elite group responsible to none. The public holds the president or parliament responsible for the economic well being of the country, yet they lack control over the government agency, the central bank that may well be the most important factor in determining the health of the economy. Monetary policy involves difficult decisions that need a long run point of view. The public holds the government responsible for the economic conditions that result from all the policies followed by government. Hence the government should have control over monetary policy. It seems to be undemocratic to say that elected officials, in a parliamentary democracy, should not be trusted to judge monetary policy.

Monetary and fiscal policies should be integrated and adequate integration cannot be achieved merely by a process of informal consultation. Rather it requires that the central bank be part of the administration. Giving the government control over the central bank need not necessarily weaken its influence, but might even strengthen it. If it were a part of the administration, the central bank counsel would then be better heeded by the government.

However, there is yet no consensus on whether an independent central bank is a good idea, although public support for independence of central bank seems to have been growing in various countries of the world.

The for and against arguments for independence of central bank may give the misleading impression that the choice is between two irreconcilable extremes. But this is not so. Even if the central bank were to lose its formal independence and become a part of government administration, there could still be an attempt to keep it out of partisan politics.

Professor Rafiqul Islam
Faculty of Business & Economics
Daffodil International University
Published in "The Financial Express"
Wednesday, January 22,2014

15
 For students of Finance and Banking
The Application of Monetary Policy: Rules, Discretion & Central Bank’s Autonomy

The debate about whether monetary policy decisions should be governed by rules or discretion has a long history. However, neither pure discretion nor fixed adherence to an intermediate monetary target has proved satisfactory. In their place several countries are moving toward a regime in which there is a clear target for the ultimate objective of monetary policy, together with a statement of the authorities decision making practices that is as open and transparent as possible.

We notice three broad phases in the approach to policy making in the postwar period. Until about the late 1960s, it was taken for granted, that formulating monetary policy required a substantial amount of discretion. From the early 1970s until the 1980s, there was a growing emphasis on rules. By the late 1980s; however, there was a swing away from rule based policy regimes. The relationship between intermediate targets and ultimate objectives became more variable under the influence of financial liberalization and innovation. In recent years it seems most central banks have recognized the need for a return to greater discretion in the use of monetary instruments.

In this context, it is necessary to provide the definition of a few terms, because the same expressions may be used to mean different things by different authors. Central banks use policy instruments to pursue ultimate policy objectives. Along the way, they are concerned with intermediate variables which are part of the policy transmission process as well as with indicator variables, which may provide information about the impact of policy, without themselves being part of the transmission mechanism.
Rules are generally taken to require the authorities to use the instruments of monetary policy to achieve a given predetermined path for an intermediate variable (usually a monetary aggregate). Intermediate variables are those which the, monetary authorities may attempt to target because of their presumed relationship with the ultimate objectives of monetary policy. The most common example of an intermediate variable is the money stock or credit stock. To the extent that growth in monetary aggregates is stably related to the ultimate objective of monetary policy (the steady growth of the nominal value of output) and to the extent that it is more feasible to control the money stock than nominal output, it makes sense to direct policy instruments towards the achievement of an intermediate variable.

Indicator variables can be defined as those that have information value about the impact of instrument on policy outcomes but are not themselves an object of control. In fact the whole range of economic quantities has a bearing on monetary policy decisions. They can include variables that in another context may be viewed as intermediate target. For example the growth of money stock can be regarded as object to be controlled. It can also be regarded as one indicator (among others) of the potential strength of demand in the economy. This underlines an important point just because a monetary variable is not used as an object of control does not mean that it does not play an important role in evaluating the stance of monetary policy.

Other indicator variables are those that convey information about the future of the economy, and the balance between inflationary and recessionary forces. They include all variables relating to the current and prospective level of real economic activity [GDP growth, industrial production, retail sales, consumer and business spending surveys, etc.]. They also include cost and price indicators [wages, import costs, consumer and producer price indices] and expectation indices, including expectations derived from financial variables such as the shape of the yield curve.

The distinction between whether variables are to be treated as indicators or intermediate targets is crucial to the distinction between rules and discretion. However, the distinction between rules and discretion is not straightforward, and, hence deserves some clarification.

The use of discretion in monetary policy is clearly not intended to imply randomness in decision making. A discretionary policy action usually reflects a systematic response by policy authorities, taken in the light of their objectives and their perceptions as to how the economy will respond to particular economic stimuli.

Arguments for discretion in the formulation and implementation of policy:

First, economics is subject to both supply shocks and demand shocks. The appropriate monetary policy response will be quite different in the two cases. If the authorities can identify the nature of different shocks, they will be able to improve welfare by exercising discretion in how they respond to them.

A second argument for discretion lies in the fact that the speed with which an economy returns to price stability following an inflationary or deflationary shock has implications for output and employment. The use of discretion may enable the central bank to tolerate some overshooting of the monetary targets to allow the return to price stability to take place in a more orderly manner.

A third argument for discretion is that the structure of the economy is changing through time in ways that cannot easily be predicted in advance. The relationship between intermediate variables and the ultimate objectives of policy can be affected by technical developments. Under such circumstances discretion, rather than a set rules, could be more appropriate.

Arguments for rules
One view is that, in a democracy, discretion from decision making should be removed from individuals and vested in rules and laws. Perhaps the more important economic argument for rule is that there is fundamentally stable relationship between an intermediate variable (a monetary aggregate) and the ultimate objective of monetary policy (the growth of nominal income). The benefits of discretion are, therefore small, since it is not possible to improve much of the outcome generated by adopting a stable money growth target. On the other hand, so the argument goes, the costs of discretion are potentially large

A subsidiary argument for rules is that financial markets operate most efficiently in the presence of certainty. If in addition to the inherent uncertainties generated by outside economic shocks, there are uncertainties about the authorities’ policy response, the difficulties faced by markets will be compounded. This argument has been formalized in the literature on the time consistency problem and the value of rules that pre-commit the authorities to a particular course of action.

The arguments in favor of rules are based more on the quality of discretionary action, than on discretion per se. it may be argued that discretionary monetary policy is subject to two systematic sources of adverse bias: too little, too late. For example, there will be greater willingness to lower interest rates than to raise them.

The Central Bank Independence: Rationale and Reality
One of the primary tenets of accepted central banking thought has been the importance of keeping central banks politically independent. No other aspect of central banking has evoked more attention and discussion than the advocacy of central bank independence of political authority. The concept of an independent central bank separates the power to create money form the power to spend money (vested in the executive). Hence, the strongest argument for an independent central bank rests on the view that subjecting the central bank to more political pressure would impart an inflationary bias to monetary policy. In the view of many observers, politicians in a democratic society are short sighted, because they are driven by the need to win their next election and they are unlikely to focus in long run objectives, such as promoting a stable price level. Instead they will seek short run solutions to problems even if the short run solutions have undesirable long run effects. A politically insulted central bank is more likely to be concerned with long run objectives and thus be a defender of a sound currency and a stable price. Putting the central bank under the control of the government is considered dangerous because the central bank can be used to facilitate financing large budget deficits and thus this help out might lead to a more inflationary bias in the economy. An independent central bank is better able to resist this pressure from government expenditure without raising taxes. An independent central bank largely removed from political pressure is needed to ensure justice to those who lose from inflation.

Another argument for central bank independence is that conduct of monetary policy is too important to leave to politicians who may have lack of expertise at making hard decisions on issues of great economic importance, such as reforming the banking system, or reducing the budget deficit. The crucial parameters like price level and exchange rate under no circumstances should be transferred into political control variable. But the removal of monetary policy form the political sphere is itself a political act. There seems to be an even stronger case for independent central bank in the developing countries given the greater frequency and arbitrariness of political change coupled with the politicization of finance .Recent research demonstrates that political instability causes instability at the central bank too, although the spillover varies across countries and type of political traditions. These are hard question which have not been addressed in the debate on central bank independence.

The Case against Independence of Central Bank
Proponents of control of central bank by government argue that it is undemocratic to have monetary policy (which affects everyone in the economy) formulated by an elite group responsible to none. The public holds the president or parliament responsible for the economic well being of the country, yet they lack control over the government agency, the central bank that may well be the most important factor in determining the health of the economy. Monetary policy involves difficult decisions that need a long run point of view. The public holds the government responsible for the economic conditions that result from all the policies followed by government. Hence the government should have control over monetary policy. It seems to be undemocratic to say that elected officials, in a parliamentary democracy, should not be trusted to judge monetary policy.

Monetary and fiscal policies should be integrated and adequate integration cannot be achieved merely by a process of informal consultation. Rather it requires that the central bank be part of the administration. Giving the government control over the central bank need not necessarily weaken its influence, but might even strengthen it. If it were a part of the administration, the central bank counsel would then be better heeded by the government.

However, there is yet no consensus on whether an independent central bank is a good idea, although public support for independence of central bank seems to have been growing in various countries of the world.

The for and against arguments for independence of central bank may give the misleading impression that the choice is between two irreconcilable extremes. But this is not so. Even if the central bank were to lose its formal independence and become a part of government administration, there could still be an attempt to keep it out of partisan politics.

Professor Rafiqul Islam
Faculty of Business & Economics
Daffodil International University
Published in "The Financial Express"
Wednesday, January 22,2014

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